Interest paid by foreign bank branches is tax deductible

In a significant ruling, the Calcutta high court has held that interest paid by branches of foreign banks operating in India to their head offices abroad is tax deductible in India. The decision was pronounced in favour of ABN Amro, a Dutch bank operating in India.

The tax department was arguing that a branch cannot claim deduction expense paid to its head office since both are “legally same persons”.

But the court overruled an earlier special bench decision of Kolkata Income Tax Appellate Tribunal on the issue in ABN Amro’s case.

Separately, the high court also held that no withholding tax was required on payment of interest by a branch to its head office.

The branches of foreign companies are taxed in India at around 42% on profits from Indian operations.

The ruling is likely to provide a major relief to the foreign banks operating in India through branches on account of interest deduction, say experts.

But they also feel that all foreign banks may not get the favourable decision which ABN Amro received.

“The court has upheld the correct legal position, but there are certain internal conflicts within the judgment, which are of concern,” an expert of a tax consulting firm said on the condition of anonymity.   

He said the decision pronounced in favour of ABN Amro may differ for some other foreign banks as the conditions may be different. So it cannot be considered an advantage for all foreign banks.

At the same time, a top official of another tax consulting firm, who did not wish to be named, said this ruling will benefit foreign banks only until they operate as branches. If foreign banks start operating as wholly owned subsidiaries, this ruling will no longer help them much.

The Reserve Bank of India (RBI) had come up with a discussion paper on the presence of foreign banks in India in January and had invited comments on the same.

The RBI is strongly in favour of supporting a subsidiary-led model for foreign banks operating in India compared with the currently existing branch model.

But Vipul Jhaveri, partner, Deloitte Haskins & Sells, said foreign banks have other advantages. According to Jhaveri, in the branch-head office model, there is a limit for the head office expenses in terms of what will be allowed as a deduction.

Whereas, in case of a wholly owned subsidiary model, there is no restriction on what is allowed as a deduction for payment to the parent so long as it is for business purpose and it is in accordance with Indian tax laws.